The Honourable Jim Flaherty, Minister of Finance, tabled Budget 2013 today. In his Budget Speech, the Minister lauded Canada’s economic strength and achievements over the last seven years, while acknowledging that there are still significant risks ahead in light of the continuing fragility of the global economy. To position Canadians to face such risks, the Economic Action Plan 2013 introduced:
- the Canada Job Grant, which is intended to provide grants to allow Canadians to obtain the skills employers are seeking,
- the Building Canada Plan, which will provide $53.5 billion over the next ten years for provincial, territorial and municipal infrastructure, and
- a package of benefits for the manufacturing sector, valued at $4.5 billion.
While there remains a projected deficit of $25.8 billion for 2012-2013, the Minister reaffirmed the Government’s commitment to balancing the budget by 2015. However, the Government is not proposing to increase tax rates and Budget 2013 does not include corporate income tax rate changes. Nevertheless, there are a number of significant tax measures in Budget 2013, many of which are, according to the Government, intended to close perceived tax loopholes, and to crack down on tax evasion and aggressive tax avoidance.
In this Budget Briefing 2013, we summarize the more significant tax proposals included in Budget 2013.
Business Income Tax Measures
International Income Tax Measures
Other Income Tax Measures
Personal Income Tax Measures
Sales Tax Measures
Other Previously Announced Measures
BUSINESS INCOME TAX MEASURES
Corporate Loss Trading
Budget 2013 proposes to introduce a new rule to target what the Government describes as a form of corporate loss trading. The Budget materials cite as an example the transfer by a profitable corporation (Profitco) of income earning assets to an unrelated corporation with tax attributes (Lossco), in return for shares of Lossco. The acquisition of control loss-restriction rules of the Income Tax Act (Canada) (the ITA), which could otherwise constrain a corporation from using its tax attributes following an acquisition of control (the loss restriction rules), do not apply to Lossco on the basis that the shares of Lossco taken back by Profitco do not give Profitco voting control over Lossco, although they would represent the majority of the fair market value of all of Lossco’s shares. Lossco would then earn income sheltered by its tax attributes, and pay to Profitco tax-free inter-corporate dividends.
The new rule applies at a particular time where: (a) a person or a group of persons first holds shares of the capital stock of a corporation (Targetco) with an aggregate fair market value that exceeds 75% of the fair market value of all of the shares of the capital stock of Targetco, (b) the person or group does not control Targetco, (c) and it is reasonable to conclude that one of the main reasons that the person or group does not control Targetco is to avoid the application of one or more loss-restriction rules. If the rule applies, then, for the purposes of the loss-restriction rules and certain other rules of the ITA, among other things, the person or group of persons is deemed at the particular time to acquire control of Targetco, and of each corporation controlled by Targetco. In determining whether the 75% value test has been met, the person, or each member of the group, as applicable, is deemed to have exercised rights it holds to acquire shares of Targetco. Certain measures are also introduced to prevent the effect of transactions entered into to avoid the application of the rule. In applying the rule, if the fair market value of the shares of Targetco is nil at any time, Targetco is deemed to have a net asset value of $100,000, and income for the current taxation year of $100,000.
Trust Loss Trading
Budget 2013 also proposes to extend the application of the loss restriction rules and related rules to trusts. The rules would apply to a trust if the trust is subject to a “loss restriction event”. Very generally, a trust will be subject to a loss restriction event when a person (including a partnership) becomes a majority-interest beneficiary of the trust, or a group of persons become a majority-interest group of beneficiaries of the trust. The concepts of majority-interest beneficiary and majority-interest group of beneficiaries will be as they apply under the affiliated persons rules of the ITA, with appropriate modifications. In general, these rules provide that a majority interest beneficiary of a trust is a beneficiary whose interest in the income or capital of the trust, together with the beneficial interests of persons or partnerships with whom the beneficiary is affiliated, has a fair market value that is greater than 50% of the fair market value of all the interests in the income or capital, respectively, of the trust.
The proposed rules that determine when a loss restriction event occurs are lengthy and detailed. Among other things, they ensure that the rules of the ITA that deem an acquisition of control of a corporation to have (or have not) occurred as a result of a particular transaction or event will apply, with appropriate modifications, to determine whether a loss restriction event has (or has not) occurred. Budget 2013 states it is expected, and appropriate from a tax policy perspective, that typical transactions or events involving changes in the beneficiaries of a personal trust will not, because of continuity of ownership rules introduced as part of these measures, result in a loss restriction event. Taxpayers are invited to submit, within 180 days after March 21, 2013 (Budget Day), comments as to whether additional transactions or events should be treated in a similar manner.
The new corporate and trust loss trading rules come into force as of Budget Day, but generally will not apply to an event or transaction that occurs on or after that time pursuant to obligations created by the terms of a written agreement entered into before Budget Day. Budget 2013 states the Government will continue to monitor the effectiveness of the constraint on trading of losses and determine whether further action is warranted.
Benefits to the Manufacturing Sector
Certain manufacturing and processing machinery and equipment that would otherwise be included in Class 43 of Schedule II of the Income Tax Regulations currently qualifies for an accelerated capital cost allowance (CCA) under Class 29 if it is acquired by a taxpayer after March 18, 2007 and before 2014. Budget 2013 extends this temporary measure by an additional period of two years so that manufacturing and processing machinery and equipment acquired in 2014 and 2015 will also qualify.
This extension forms part of a package of benefits to the manufacturing sector valued at $4.5 billion, including $1.4 billion in foregone tax revenues over three years for this extension, $1 billion over 5 years for aerospace development (previously committed), $200 million over five years for a new Advance Manufacturing Fund in Ontario and $92 million over two years for forestry innovation. In addition, the Government proposes to expend $53.5 billion over five years on public projects.
Scientific Research and Experimental Development Program – Disclosure of Third Parties
Budget 2013 proposes to introduce additional information reporting measures with respect to Scientific Research & Experimental Development (SR&ED) claims where the risk of non-compliance is perceived to be high. In particular, detailed information about SR&ED program tax preparers and billing arrangements will be required to be provided on program claim forms where one or more third parties have assisted with the preparation of a claim. A claimant will otherwise be required to certify that no third party assisted in any aspect of the preparation of the SR&ED claim.
Budget 2013 also proposes that a $1,000 penalty be imposed on each SR&ED program claim for which the information about the SR&ED program tax preparers and billing arrangements is missing, incomplete or inaccurate. A third party preparer who has assisted in the preparation of the claim will be jointly and severally, or solidarily, liable for the penalty.
These proposals apply to SR&ED program claims filed on or after the later of January 1, 2014 and the day the enacting legislation receives Royal Assent.
Future Reclamation Costs
Under the ITA, a taxpayer earning income from a business may generally claim a reserve for amounts received in a taxation year in respect of services that may reasonably be expected to be rendered after the end of that taxation year. In the Government’s view, this reserve is not intended to provide relief for taxpayers who have rendered services to customers, but who have future obligations to persons other than customers arising from the provision of such services. Consequently, Budget 2013 proposes to amend the ITA to make the reserve inapplicable to amounts received in respect of future reclamation obligations. Budget 2013 states that taxpayers with future reclamation obligations are generally eligible to use the Qualifying Environmental Trust rules.
Budget 2013 proposes two new measures intended to more closely align the deduction rates for tangible and intangible costs incurred in the mining sector with those incurred in the oil and gas sector, including bituminous sands. First, the deduction rate for pre-production development costs (essentially intangible expenses incurred for the purpose of bringing a new mine into production in reasonable commercial quantities) will be reduced from 100% to 30% per year, on a declining balance basis. This change is effective as of 2018 for expenses incurred under an existing written agreement, or in respect of a new mine on which construction was started or engineering and design work began before Budget Day. For other costs, the change will be phased in on a gradual basis, beginning in 2015 until 2018.
Budget 2013 also proposes to phase out the accelerated CCA deduction that currently applies, in addition to the normal 25% CCA rate, for the cost of most machinery, equipment and structures acquired for use in new mines or eligible mine expansions. Under the transitional measures proposed, the accelerated CCA deduction will continue to be available in respect of assets acquired before 2018 either under an existing written agreement, or in respect of a new mine or as part of an eligible mine expansion on which construction was started or engineering and design work began before Budget Day. For other assets, the accelerated CCA deduction will be phased out on a gradual basis beginning in 2017 until 2021.
Taxation of Corporate Groups
Budget 2013 announces the completion of the Government’s previously announced initiative to review whether new rules for the taxation of corporate groups - such as the introduction of a formal system for loss transfers or consolidating reporting - could improve the functioning of the tax system. The Government has determined that moving to a formal system of corporate group taxation is not a priority as this time. However, going forward, the Government will continue to work with provinces and territories regarding their concerns with current approaches to loss utilization.
INTERNATIONAL INCOME TAX MEASURES
Thin Capitalization Rules
Following on the expansion to the thin capitalization or “thin cap” rules in the 2012 federal budget (described in Osler’s Budget Briefing 2012), Budget 2013 proposes to further expand the scope of these rules to debts of Canadian-resident trusts and to those of certain non-resident corporations and trusts. Canadian-resident trusts and non-resident corporations and trusts that are members of partnerships would also be allocated their “specified proportions” of partnership debts.
In general, the thin cap rules deny the deduction of interest paid by a Canadian-resident corporation to certain non-resident shareholders of the corporation or non-resident persons that do not deal at arm’s length with such shareholders to the extent that a 1.5:1 debt-to-equity ratio is exceeded (determined under specific rules in the ITA). Interest that has been denied under the thin cap rules will be deemed to have been paid as a dividend by the Canadian-resident corporation.
Currently, the thin cap rules apply only to debts of Canadian-resident corporations (directly or as a member of a partnership). Budget 2013 proposes to extend the thin cap rules to apply to debts of Canadian-resident trusts. The existing thin cap rules would be modified in several respects to take into account the differences between a trust and a corporation.
Where an amount of interest of a Canadian-resident trust is not deductible because of the application of the extended thin cap rules, Budget 2013 proposes that the trust may designate all or a portion of such amount as having been paid to the non-resident recipient as a beneficiary of the trust, and not as interest. This would allow the trust to deduct the designated payment in computing its income under the ITA, but the designated payment would be subject to non-resident withholding tax (and, in certain cases, an additional tax on “designated income” of the trust).
Budget 2013 introduces the concept of a “specified non-resident beneficiary” of a trust, which generally includes a non-resident beneficiary of the trust who, either alone or together with non-arm’s length persons, has an interest as a beneficiary under the trust with a fair market value that is at least 25% of the fair market value of all interests as a beneficiary under the trust. Similar to the rules for determining whether a person is a specified shareholder of a corporation, certain deeming rules would cause a person to be deemed to hold interests in a trust or to have exercised rights in respect of interests in a trust for the purposes of the specified non-resident beneficiary definition. Additionally, where the amount of income or capital of the trust that the person may receive depends on an exercise of (or the failure to exercise) a discretionary power, that power is deemed to have been exercised (or failed to have been exercised).
The equity of a Canadian-resident trust will generally include contributions by specified non-resident beneficiaries and a proxy for trust retained earnings. Specifically, Budget 2013 proposes that the “equity amount” will be the amount by which (a) the total of (i) all equity contributions (defined as transfers of property to the trust in exchange for interests or rights to acquire interests as beneficiaries of the trust, or transfers of property to the trust by beneficiaries for no consideration) made by specified non-resident beneficiaries (measured on the basis of the average of all such contributions before each month of the year) and (ii) the “tax-paid earnings” of the trust for the year (measured as the taxable income of the trust less the federal and provincial tax payable by the trust for the year), exceeds (b) the total of all amounts paid or payable by the trust to specified non-resident beneficiaries (measured on the basis of the average of all such amounts before each month of the year), except to the extent the amounts are included in the beneficiaries’ income under the ITA or are subject to non-resident withholding tax.
Recognizing that trusts may not have complete historical records enabling them to determine their “equity amounts”, Budget 2013 proposes that an existing trust will be able to elect to determine its “equity amount” on Budget Day based on the fair market value of its assets less the amount of its liabilities at the beginning of Budget Day. This deemed trust equity would be deemed to have been contributed by the trust’s beneficiaries in proportion to the relative fair market values of their beneficial interests on Budget Day. Contributions, tax-paid earnings and distributions on or after Budget Day would be added to (or subtracted from) the trust’s “equity amount” for purposes of the thin cap rules.
Non-Resident Corporations and Trusts
Budget 2013 also proposes to extend the thin cap rules to non-resident corporations and trusts that have otherwise deductible interest expense under the ITA (e.g., because they carry on business in Canada through a branch). Under the proposals, the Canadian banking business of an authorized foreign bank would be excluded.
For purposes of the application of the thin cap rules to non-resident corporations and trusts, Budget 2013 proposes a 3:5 debt-to-asset ratio to parallel the 1.5:1 debt-to-equity ratio used for Canadian resident corporations. More specifically, the “equity amount” of a non-resident corporation or trust is defined as being 40% of the amount by which the cost of the non-resident’s properties used or held in the course of carrying on business in Canada or, in the case of a corporation or trust that elects to be taxed on its net income under the ITA rather than being subject to non-resident withholding tax on its gross rental income, generally, its Canadian real property (in either case, measured on the basis of the average of all such amounts for each month of the year) exceeds the total of its liabilities other than, generally, debts that are owed to specified non-residents (measured on the basis of the average of all such amounts for each month of the year). In measuring the cost of a non-resident’s properties for this purpose, partnership interests are excluded.
Although the proposals are not limited on their face to non-resident corporations and trusts that carry on activities the income from which is taxable in Canada under the ITA and any applicable tax treaty, that is their effect, since only such non-resident corporations and trusts should have interest expense that would otherwise be deductible under the ITA. Non-resident trusts and corporations that may be subject to the extended thin cap rules should review any applicable tax treaty to determine whether relief may be available.
All the thin cap proposals apply to taxation years that begin after 2013 and will apply to existing as well as new borrowings.
The non-resident trust rules of the ITA provide that where property is contributed by a Canadian resident taxpayer to a non-resident trust, the trust may be deemed to be a resident of Canada for most purposes of the ITA. These and related rules are proposed to be amended in response to the Federal Court of Appeal decision in The Queen v. Sommerer. In that case, the Court held that a trust attribution rule of the ITA did not apply in circumstances where the trust acquired property in exchange for fair market value consideration. The attribution rule applies to attribute to a Canadian resident taxpayer income from property held by a trust in circumstances where the taxpayer has effective ownership of the property. Such effective ownership arises where the property can revert to the taxpayer, or the taxpayer has influence over the trust’s dealings in respect of the property. Budget 2013 first proposes to restrict the application of the trust attribution rule to trusts resident in Canada determined without regard to the non-resident trust rules. Second, the non-resident trust rules are proposed to be amended so as to apply where a Canadian-resident taxpayer maintains effective ownership of property held by a non-resident trust, as described above for purposes of the trust attribution rule. Any transfer or loan of the property made directly or indirectly by the taxpayer, regardless of any consideration exchanged, will be treated as a transfer of restricted property by the taxpayer for purposes of the non-resident trust rules. The result will generally be to cause the taxpayer to be treated as having made a contribution to the non-resident trust, so that the non-resident trust will be deemed to be a resident of Canada in accordance with the non-resident trust rules. Finally, the provision of the ITA that prevents a trust from distributing property to a beneficiary on a tax-deferred basis where the property is subject to the trust attribution rule, is proposed to be extended to apply to the effectively owned property that is subject to these proposals.
These proposals apply to taxation years ended on or after Budget Day.
International Tax Evasion and Aggressive Tax Avoidance
Specified Foreign Property
A Canadian-resident that owns “specified foreign property” (including, generally, certain funds or property situated, deposited or held outside Canada and certain interests in non-resident entities and indebtedness owed by non-resident persons) with a cost in excess of $100,000 must file a Foreign Income Verification Statement (Form T1135). Budget 2013 proposes to extend the normal reassessment period for a taxation year of a taxpayer by three years if the taxpayer has failed to report income from a specified foreign property on its annual tax return, and the Form T1135 was not filed on time, or a specified foreign property was not identified, or was improperly identified, on the Form T1135.
In addition, Budget 2013 proposes to revise Form T1135 to require more detailed information regarding specified foreign property. These proposals apply to the 2013 and subsequent taxation years.
Information Requirements Regarding Unnamed Persons
Tax legislation allows the Minister of National Revenue (the Minister) to require any person to provide information or documents for the purposes of tax administration or enforcement. However, before issuing a requirement to a third party to provide information relating to unnamed persons, the Minister must first obtain a court order.
The current rules contemplate that the Minister may obtain this order on an ex parte basis - without notifying the third party of the application. The rules also provide the third party with specific rights to seek a review of the issuance of the court order. Parties have successfully challenged requirements relating to unnamed persons in cases such as Minister of National Revenue v. RBC Life Insurance Company, where it was found that the third party requirements were invalid because the Minister had failed to make full and frank disclosure in obtaining the ex parte order. On the basis that such challenges “significantly delay the obtaining of the information and consequently the audit and tax reassessment process”, Budget 2013 proposes to eliminate the ex parte nature of the Minister’s application as well as the ITA provisions that set out specific rights of review. This proposal is effective on the day the enacting legislation receives Royal Assent.
International Electronic Funds Transfers
Budget 2013 proposes to amend the ITA and the ETA to require certain financial intermediaries to report to the Canada Revenue Agency (CRA) international electronic funds transfers of $10,000 or more. These requirements are intended to mirror current requirements in the Proceeds of Crime (Money Laundering) and Terrorist Financing Act. Reporting will be required beginning in 2015.
Stop International Tax Evasion Program
Budget 2013 proposes that the CRA will launch a program under which it will pay rewards to individuals that provide information to the CRA that leads to the collection of outstanding taxes due in respect of major international tax non-compliance. Rewards would be paid of up to 15% of federal tax collected if the information results in total additional assessments or reassessments exceeding $100,000 in federal tax.
Budget 2013 reaffirms the intention of the Canadian government to pursue an intergovernmental agreement with the United States that would enhance the sharing of tax information under the Canada-United States Income Tax Convention. According to Budget 2013, this agreement would include provisions which “support” the Foreign Account Tax Compliance Act (“FATCA”) rules passed by the United States Congress in 2010. The FATCA rules, which begin to become effective starting on January 1, 2014, represent a sweeping new paradigm for the enforcement of tax transparency by the United States. Under the FATCA regime, a wide range of direct and indirect U.S. payments made to non-U.S. financial institutions (and certain other non-U.S. entities) will be subject to a new 30% U.S. withholding tax unless the financial institution agrees to report extensive information about its U.S. account holders and owners to the IRS. The FATCA rules are extraordinarily complex and invasive in scope.
To date, the United States has signed intergovernmental agreements with the United Kingdom, Mexico, Ireland, Denmark, and Switzerland to clarify and simplify the application of FATCA to entities in those countries. In November 2012, the United States announced that it is working with more than 50 countries worldwide in negotiating FATCA intergovernmental agreements, including Canada. Budget 2013 indicates that Canada and the United states are negotiating a reciprocal agreement that would include a commitment by Canada and the United States to work with other trading partners to adapt the terms of this agreement to build a broader based common multilateral framework for the automatic exchange of tax information among partnering countries.
Budget 2013 notes that the Government has been largely unsuccessful in challenging perceived “treaty shopping” in court, a likely reference to cases such as MIL Investments, Prevost Car and Velcro. Budget 2013 states the Government intends to consult on measures that would “protect the integrity of Canada’s tax treaties while preserving a business tax environment that is conducive to foreign investment”, promising to release a consultation paper to provide stakeholders with an opportunity to comment on possible measures. No specific measures are proposed in Budget 2013.
OTHER INCOME TAX MEASURES
Synthetic Disposition Arrangements
Appreciation on many properties, including capital properties, is recognized for tax purposes on a realization basis upon disposition of the property. If a taxpayer chooses to enter into arrangements to hedge its risk of loss or opportunity for gain in respect of the appreciated property without disposing of the property, generally speaking, no immediate disposition of the property results and the recognition for tax purposes of the appreciation on the property will continue to be deferred until disposition.
Budget 2013 proposes to change this treatment where a taxpayer enters into an arrangement that has the effect of eliminating all or substantially all the taxpayer’s risk of loss and opportunity for gain or profit in respect of the property (a synthetic disposition arrangement) for a period of more than one year. Budget 2013 proposes to deem such arrangements to result in a disposition and reacquisition of the property at fair market value.
Similar treatment applies where the arrangement is entered into by a person or partnership with whom the taxpayer does not deal at arm’s length and such arrangement can reasonably be considered to have been entered into, in whole or in part, with the purpose of obtaining the effect outlined above. Tax deferred conversions of property and leases of tangible property are not subject to this 2013 Budget proposal.
Such proposal would apply to so-called “monetization” transactions, but a deemed gain could arise as a result of the application of this proposal even if the taxpayer has not obtained funds, whether by loan or otherwise, against the hedged appreciated property.
Under parallel proposals, if a taxpayer has entered into a synthetic disposition arrangement for a period of more than 30 days, the taxpayer will be deemed to have disposed of and to have reacquired the property, interrupting the statutory one-year holding period applicable to dividend stop-loss rules and limitations on foreign tax credits.
These proposals apply to agreements and arrangements entered into or extended on or after Budget Day.
Character Conversion Transactions
Budget 2013 includes proposals that would affect the characterization of gains and losses in respect of capital property sold or received under certain forward sale agreements, deeming such gains and losses to arise on income, rather than capital, account.
The proposals apply to an agreement (a derivative forward agreement) for the sale or purchase of capital property, where the term of the agreement is greater than 180 days (or shorter where the agreement is part of a series of agreements having a collective term greater than 180 days) and the sale price of the capital property sold, or value of the capital property received, under the agreement is determined by reference to a measure other than the value of the capital property, capital gains in respect of the capital property, or income or certain other distributions in respect of the capital property.
Forward contracts of this type have long been employed by investment funds to obtain investment returns that are otherwise difficult to achieve. For example, in the late 1990’s, the CRA issued numerous advance tax rulings permitting Canadian mutual funds to use similar forward agreements to mimic the return on foreign investments that, if held directly, could give rise to penalty taxes under the now-repealed “foreign property” regime.
Under the proposals in Budget 2013, the amount of any capital gain or loss in respect of a derivative forward agreement that is recharacterized on income account would be added to or subtracted from the cost of the affected capital property. In this way, the gain or loss would not be treated as both a deemed income gain or loss and an actual capital gain or loss.
These proposals apply to agreements entered into or extended on or after Budget Day.
Leveraged Life Insurance Arrangements
Budget 2013 will eliminate what the Government refers to as “multiple and unintended tax benefits” arising from two life insurance arrangements involving the use of borrowed funds. The two arrangements targeted by the Government are referred to as the “leveraged insured annuity” and the “10/8 arrangement”.
Although specific rules have been proposed to deny the “multiple and unintended tax benefits”, the Government warns that it will be monitoring developments and, if structures or transactions emerge that undermine the effectiveness of the proposals, it may take further action with possible retroactive application.
Leveraged Insured Annuities
Generally, a “leveraged insured annuity” involves the use by a taxpayer of borrowed funds to pay a single premium to acquire an annuity under which annuity payments will be made for the lifetime of the annuitant. The taxpayer may then buy a life insurance policy that has an insurance amount on the life of the annuitant (the life insured) equal to the single premium paid to acquire the annuity and pay annual premiums on that policy. To secure the borrowing, the taxpayer may assign both the annuity and the life insurance policy to the lender. If the arrangement remains in place until the death of the annuitant, the life insurance proceeds may be applied to repay the borrowed funds.
From an income tax perspective, if the annuity is one to which section 12.2 of the ITA applies, an amount in respect of such an annuity is required to be included in the taxpayer’s income annually. Interest paid by the taxpayer on the borrowed funds is deductible under the ITA to the extent of such income. A portion of the premiums paid on the life insurance policy may also be deductible under the ITA as a cost of borrowing. Provided that the life insurance policy qualifies as an “exempt policy” for the purposes of the ITA, there is no income from the life insurance policy while it remains in force and, on the death of the annuitant, the death benefit proceeds of the life insurance policy are received free of any income taxes and may be applied to repay the borrowed funds. In effect, the taxpayer may receive a portion of the annuity payments free of any income tax while the annuitant is alive and, thereafter, repay the borrowed funds from the tax free death benefit proceeds of the life insurance policy.
Where such an arrangement is entered into by a private corporation with the shareholder as the annuitant, there may be a reduction in the fair market value of the shares for tax purposes immediately before the death of the shareholder (with a consequent reduction in the capital gain deemed to have been realized on death). Moreover, any death benefit proceeds in excess of the tax cost of the policy will be added to the corporation’s capital dividend account and may be distributed tax free to a shareholder as a capital dividend.
Budget 2013 describes these tax consequences as being unintended and introduces rules that will apply to such arrangements to deny the perceived tax benefits.
The new rules will apply to an “LIA policy”, which will be a life insurance policy (other than an annuity) where (i) a person becomes obligated on or after Budget Day to repay an amount to another person or partnership (the “lender”) at a time determined by reference to the death of a particular individual whose life is insured under the life insurance policy, and (ii) the lender is assigned an interest in the life insurance policy and in an annuity contract that provides for payments at least until the death of the particular individual whose life is insured under the life insurance policy.
For taxation years that end on or after Budget Day, where a life insurance policy is an LIA policy and any amounts are borrowed on or after Budget Day from the lender:
- the policy will not be an “exempt policy” for the purposes of the ITA and the income accrual rules will apply to the LIA policy,
- deductions for borrowing costs will be denied in respect of premiums paid under the LIA policy,
- for purposes of certain deemed disposition rules that apply on the death of the taxpayer, the fair market value of any property deemed to have been disposed of as a consequence of the death of the annuitant under an annuity contract in respect of the LIA policy will be determined as though the fair market value of the annuity contract were equal to the total premium paid under the contract on or before death,
- no portion of the life insurance proceeds will be added to the capital dividend account of a private corporation, and
- the insurer will be required to file an information return in respect of the LIA policy for a calendar year if the insurer was notified by, or on behalf of, the policyholder that the life insurance policy is a LIA policy or if it is reasonable to conclude that the insurer knew, or ought to have known, before the end of the calendar year that the policy is a LIA policy.
The second arrangement targeted by the Government also involves the use of borrowed funds and a life insurance policy.
It is not uncommon for a taxpayer who has paid premiums under a life insurance policy to borrow an amount from the insurer by way of a policy loan under the terms of the life insurance policy or from any lender as a loan secured by the life insurance policy as collateral. The borrowed funds are then used by the taxpayer to invest in other income producing property or a business. By itself, that does not appear to trouble the Government.
However, in some arrangements, the interest rate credited under the life insurance policy may be determined, under the terms of the life insurance policy, by reference to the interest rate paid on the borrowed funds. The “10/8 arrangement” derives its name from the interest rates commonly used under such arrangements: a 10% interest rate on the borrowed funds and an 8% interest credit under the policy.
Under a 10/8 arrangement, the 10% interest paid by the taxpayer on the borrowed funds is deductible under the ITA to the extent the borrowed funds are used for an income producing purpose. A portion of the premiums paid on the life insurance policy may also be deductible under the ITA as a cost of borrowing. Provided that the life insurance policy qualifies as an “exempt policy” for the purposes of the ITA, there is no income from the life insurance policy while it remains in force and, on the death of the life insured, the death benefit proceeds are received free of any income taxes and may be applied to repay the borrowed funds. Consequently, the taxpayer may deduct the 10% interest paid on the borrowed funds against any income produced by the use of those funds, receive the 8% credits under the life insurance policy on death of the life insured as part of the death benefit proceeds free of any income tax and, thereafter, repay the borrowed funds from the tax free death benefit proceeds of the life insurance policy.
Where such an arrangement is entered into by a private corporation, any death benefit proceeds in excess of the tax cost of the policy will be added to the corporation’s capital dividend account and may be distributed tax free to a shareholder as a capital dividend.
It appears that the Government believes that, but for the tax benefits of such an arrangement, the payment of premiums and the borrowing of funds would not have been undertaken. Although the Government is challenging 10/8 arrangements under existing provisions of the ITA, Budget 2013 proposes new rules to prevent the use of such arrangements in the future.
The new rules will apply for taxation years ending on or after Budget Day to 10/8 arrangements and will deny interest deductions, premium deductions and additions to the capital dividend account arising for periods after 2013. The Government will also encourage taxpayers to terminate existing 10/8 arrangements before 2014 by providing relief from certain income tax consequences that would otherwise arise on a withdrawal from a life insurance policy that is part of such an arrangement if the withdrawal is made, after Budget Day and before January 1, 2014, to repay funds borrowed under the 10/8 arrangement.
Reassessment and Collection Proposals
Budget 2013 proposes to give the CRA additional time to reassess a taxpayer that has participated in a tax shelter or a “reportable transaction”, in each case where the required filing of an information return was not made on time. To combat what the Government describes as reduced time for the CRA to obtain the information necessary for a proper audit when the required information return is filed late, the CRA will be able to reassess a taxpayer in these situations beyond the normal statutory reassessment period, provided such reassessment is made within three years after the date on which the required information return is filed. An effect of the 2013 Budget proposal is to extend the reassessment period for a GAAR reassessment based upon an abuse of the ITA in respect of a “reportable transaction” which is not timely reported to CRA.
This proposal applies to reassessments of taxation years that end on or after Budget Day.
Tax Collection for Disputed Tax Shelters
Budget 2013 proposes to give the CRA the power to collect 50% of disputed tax, interest and penalties resulting from the disallowance of a charitable donation deduction or tax credit in respect of a tax shelter. Although the CRA is generally prohibited from taking collection action where a taxpayer that is not a large corporation has objected to a reassessment, the Government has expressed concern that prolonged tax shelter litigation could delay final collection of the taxes. As a result, this proposal allows the CRA to collect 50% of the disputed amount in these circumstances. Budget 2013 does not make any changes with respect to the collection provisions that apply to large corporations or amounts in dispute other than those related to charitable donation tax shelters.
This proposal will apply in respect of amounts assessed for the 2013 and subsequent taxation years.
PERSONAL INCOME TAX MEASURES
Lifetime Capital Gains Exemption
The individual lifetime capital gains exemption limit of $750,000 will be increased to $800,000 effective for the 2014 taxation year, and will be indexed to inflation for taxation years after 2014.
Dividend Tax Credit
Budget 2013 proposes to reduce the effective rate of the dividend tax credit applicable to non-eligible dividends (i.e., dividends paid out of income that was taxed at a lower rate, generally being the small business income tax rate), such that the effective tax rate applicable to non-eligible dividends will increase. This proposal applies to non-eligible dividends paid after 2013.
Registered Pension Plan Contribution Errors
Budget 2013 proposes to allow administrators of registered pension plans (RPPs) to make a refund to correct a contribution that was made as the result of a reasonable error, without first obtaining approval from the CRA, if the refund is made no later than December 31 of the year following the year in which the inadvertent contribution was made. If an RPP administrator seeks to correct a contribution error after the deadline, the existing procedure of obtaining authorization from the CRA will continue to apply.
This proposal applies to RPP contributions made on or after the later of January 1, 2014, and the day the enacting legislation receives Royal Assent.
Mineral Exploration Tax Credit
Individuals (other than trusts) who invest in flow-through shares may be entitled to additional tax benefits in addition to the renounced exploration expenses available on all flow-through shares. Where certain qualifying expenditures (essentially expenses incurred in mining exploration above or at ground level) are incurred and renounced to a holder of flow-through shares who is an individual (other than a trust), that holder is entitled to an investment tax credit equal to 15% of the renounced qualifying expenditures. This tax credit on “grass-roots” surface exploration expenditures is called the “mineral exploration tax credit.” As has been the case over the last several budgets, Budget 2013 proposes to extend the 15% mineral exploration tax credit for another year.
Labour-Sponsored Venture Capital Corporations Tax Credit
Budget 2013 proposes to phase out the federal Labour-Sponsored Venture Capital Corporations (LSVCC) tax credit by 2017. As of Budget Day, an LSVCC can no longer be federally registered or prescribed for purposes of this credit.
SALES TAX MEASURES
GST/HST Rules Relating to Certain Registered Pension Plans
Budget 2013 proposes two much-anticipated measures to simplify employer compliance with the existing, complex GST/HST rules for certain registered employee pension plans. Under the current rules, situations can arise where an employer participating in a registered pension plan must account for GST/HST on the same plan-related expense twice (i.e., on both an actual supply made by the employer to the pension plan entity during a fiscal year, and a supply that is deemed to be made by the employer to that entity at the end of the year). In those cases, the employer must then resort to a complicated tax adjustment mechanism to avoid double taxation. To simplify compliance, Budget 2013 proposes a new election, to be made jointly by the employer and the pension entity, which would, in effect, permit the employer to account for GST/HST only once in respect of a particular plan-related expense (i.e., on the deemed supply). Once made, the joint election generally would remain in effect until it is jointly revoked by the employer and the pension entity, effective from the beginning of a fiscal year of the employer. However, if the employer fails to remit tax on deemed supplies as required, the Minister of National Revenue will have the power to cancel an election, retroactive to the beginning of a fiscal year, and to assess the employer for tax and interest on the basis of the existing rules as if the election had not been made for that year. This measure will apply to supplies made after Budget Day.
Budget 2013 also proposes a new de minimis threshold test for employers participating in certain registered pension plans, whereby employers below the threshold (e.g., those with minimal pension-plan related activities) would be exempted from the requirement to comply with certain of the GST/HST rules relating to pension plans. Special rules will apply with respect to the application of the thresholds in the case of related employers and mergers, amalgamations or wind-ups of participating employers. This proposal applies in respect of any fiscal year of an employer that begins after Budget Day.
GST/HST Business Information Requirement
When registering a business for GST/HST purposes, registrants must provide the CRA with various items of information, including the operating name of the business, ownership details and their main business activity. The penalty for failure to provide the required information is currently $100. Budget 2013 proposes a stiffer penalty, being the authority for the Minister to withhold GST/HST refunds otherwise payable to the registrant until such time as the Minister is satisfied that all of the prescribed business identification information has been provided and is accurate. This proposal applies on the day the enacting legislation receives Royal Assent.
Retroactive Amendment to Tax Certain Paid Parking Supplied by Charities, Hospitals and Other Public Sector Bodies
Paid parking that is supplied in the course of a business generally is taxable under the current GST/HST rules. However, under the legislation as it has read since the inception of the GST in 1991, there are broad general exemptions for charities and other public sector bodies that, in certain circumstances, could encompass their supplies of paid parking supplied on a regular or continuous basis (such as parking facilities operated by a university or hospital). Budget 2013 proposes an amendment, going back 22 years, to take away those exemptions for such paid parking supplied by a public sector body. The retroactive amendment is proposed to come into effect on December 17, 1990, the day the original GST legislation was enacted. Occasional supplies of paid parking by a public sector body, such as those made as part of a special fund-raising event, would continue to qualify for exemption.
Home Care and Personal Care Services
Budget 2013 expands an existing GST/HST exemption for certain publicly-subsidized or funded homemaker or personal care services for individuals who require assistance in their homes due to age, infirmity or a disability. The exemption is extended to more such services that are currently being subsidized or funded by provincial and territorial governments. This proposal applies to supplies made after Budget Day.
Medical Reports and Services for Non-Health Care Purposes
Budget 2013 tightens the GST/HST basic exemption for health care services to ensure that reports, examinations and other services that are not performed for health care purposes (e.g., services or reports obtained solely for insurance purposes) are generally taxable. Reports, examinations or other services paid for by a provincial or territorial health insurance plan will continue to be exempt. This proposal applies to supplies made after Budget Day.
OTHER PREVIOUSLY ANNOUNCED MEASURES
2013 Budget confirms the Government’s intention to proceed with a number of previously announced tax measures, as modified to take into account consultations and deliberations since their release, including the following:
- Proposed changes to certain GST/HST rules relating to financial institutions released on January 28, 2011.
- Legislative proposals implementing the proposed changes to the life insurance policyholder exemption test announced in the March 29, 2012 Budget.
- Legislative proposals released on June 8, 2012 relating to improving the caseload management of the Tax Court of Canada.
- Legislative proposals released on July 25, 2012 relating to specified investment flow-through entities, real estate investment trusts and publicly-traded corporations.
- Legislative proposals released on November 27, 2012 relating to income tax rules applicable to Canadian banks with foreign affiliates.
- Legislative proposals released on December 21, 2012 relating to income tax technical amendments.
- Automobile expense amounts for 2012 announced on December 29, 2011 and for 2013 announced on December 28, 2012.
Budget 2013 also reaffirms the Government’s commitment to move forward as required with technical amendments to improve the certainty of the tax system.
To access the 2013 Budget and related documents, click here.
If you have any questions or require additional analysis on the 2013 Budget tax measures, please contact any member of our National Tax Department.